 BANKING
 PART I
Chicago's "End the Fed"
Protest 11/22/09
BANKING, MONEY AND THE
FED
WHAT IS MONEY?
WHY DO WE NEED IT?
HOW CAN WE GET IT?
IS THERE EVER ENOUGH?
IS THERE EVER TOO MUCH????
WHAT BACKS OUR MONEY?
What Gives Money Its Value?
 Our money today has value because of its general
acceptability.
Three Kinds of Economic Goods
 Consumer goods (end product)
 Capital goods (human, tools,machinery)
 Money (medium of exchange-store of value-
a liquid asset- deferred payment- basis for
quoting prices)
Money is the most important part of market
economy-it is at least one part of a barter
transaction and whatever affects money
affects everything else.
The larger the money supply >our demand for
G & S.
***More money available the more willing to
spend
Money Differs From Other Economic Goods
It’s supply must remain scarce for it to be valuable
 By itself it is nothing….. Must be circulated in
the economy by consuming or saving.
 If quantities of dollars increase in economy,
benefits go to those who get it first rather than
who gets it last, because the first with the $$
can spend it with lower prices…
 It is only useful for what it gets you in
exchange for what you want.

Last to get the $$$ run the risk of inflation
having set in.
Money vs. Barter
 Money - Any good that is widely accepted for
purposes of exchange and in the repayment of debt.
 Barter - Exchanging goods and services for other
goods and services without the use of money.
HISTORY OF MONEY
 Barter was symbol of primitive culture
 Homer wrote about cattle being used as
barter in the Illiad
What are some of the things used as
money?
rats, pigs, whales, teeth, tobacco,
beads, women, cattle
 Why was gold and silver best used as
money?
durable, convenient to handle,
portable,difficult for supply to be
increased, gold= glistened
Barter is inefficient and expensive
Deteriorates after few trades
Requires a double co-incidence of wants.
Too costly to travel long distances
(trading a cow for a fuzzy fleece from L.L. Bean)
Coins were adopted
 Money concept was born…
 Silver Gold
 Then currency – 1863…. “In God We Trust.”
COMPONENTS OF MONEY
 M1= Currency coins,
demand deposits, travelers
checks
 M2=M1+Savings deposits,
small time deposits (under
$100,000), money market
mutual funds.
 M3=M1+M2+large
denomination time deposits
(over $100,000)
 LM3 + liquid assets (T-bills,
U.S.Savings bonds,
commercial paper)
 Near Monies:
Credit cards
Stocks and Bonds
IRA’s
401 K
Four functions of money
 Medium of exchange
 Basis for quoting prices
 Store of value (can accumulate wealth by saving)
 Standard of deferred payment (buy now, pay later…
no payments until 2020) Money will be good to pay
in 2020 as is today.
Are Credit and Debit Cards Money?
Yes!
 Credit card use represents loans which must be
repaid. They represent the use of someone else's
money.
 Debit cards give access to checkable deposits which
are already part of the money supply.
Value of Money
 How much money do you have:




in your pocket
in your checking account
in your savings account
Money has value- too much in circulation,
decreases its value……. inflation is BAD
What backs our currency?
Our money is called what?
What will a dollar buy today?
FEDERAL RESERVE STRUCTURE
One of 7
is
Chairman
Board of Governors
7 Members
12 District
Banks
Member Banks
FED Can Issue Federal Reserve Notes……………….
Have you ever seen a Federal Reserve Note?
Do any of you have any Federal Reserve Notes?
A=Boston
B= New York
C= Philadelphia
D= Cleveland
E= Richmond, VA
F= Atlanta
G= Chicago
H= St. Louis
I= Minneapolis
J= Kansas City
K= Dallas
L= San Francisco
12 District Banks.
Dallas is the 11th District… K
http://www.dallasfed.org/
25 Regional Banks.
Dallas has region banks in El Paso, San Antonio,
Houston.
12 Regional Banks
10. J. Kansas City
11. K. Dallas*
12.L. San Francisco
1. A. Boston
2. B. NY
3.C. Philadelphia
4.D. Cleveland
5.E. Richmond, VA
6.F. Atlanta
7. G. Chicago
8.H. St. Louis
9. I. Minneapolis
BOARD OF GOVERNORS DUTIES
 Appointed by Pres/confirmed by Senate Serve 14 year terms-2 years rotational
 One appointed Chairman
 Supervises the issuance and distribution of federal
reserve notes. *
 Regulates all money and credit policies in U.S.
 Supervises all 12 District Banks
Duties Continued
 Sets Reserve Requirements- all banks required






today.
Sets Discount Rate
Serves as Majority of FOMC
Sets Margin Rates for purchasing stocks
Maintain stability of financial system
Provide certain financial services for U.S. govt
Regulates state banks that join.
FOMC sets the Federal Funds Rate and then each
District Bank sets their Discount Rate.
(they tend to be aligned.)
What is the Federal Funds Rate
Today? 11/19/14 .25
7/1 /10 .25
4/22/10 .25
4/20/09 .25
11/17/08 1.00%
4/15/08 2.25 %
4/16/07 5.25%
6/29/06 5.18%
4/17/06, 5.00%
11/21/05, 4.15%
Was 2.875%(spring, 2005)
(was 2% 12/2004)
(2003, FFR was 1.0%)
Federal Funds Rate
 http://research.stlouisfed.org/fred2/series/FEDFU
NDS/
Is the Fed effective???--------What is the Discount Rate today? 11/19/14 .75%
7/1/10 .75%
4/22/2010 .75
4/20/09 .50
11/17/08 1.25%
4/15/08 2.50
4/16/07 6.25%
6/29/06 6.00%
4/17/06 5.75%
11/21/05 5.00%
Spring, 2005 3.75%
Dec. 2004, 3.00%
Discount Rate
 http://www.ny.frb.org/banking/discountwindow.ht
ml
Prime Rate? – Today 11/19/14 3.25
7/1/10 3.25
4/22/10 3.25
4/20/09 3.25%
11/17/08 4.00%
5/15/08 5.25%
4/16/07 8.25%
6/29/06, 8.00%
4/17/06, 7.75%,
11/21, 7.00%
(was 5.75% in spring 2005)
(was 5.00 12/2004)?
Where does fiscal policy enter in here?
WHO BELONGS TO THE FED?
 All National Banks
 State Banks may opt to join
 Monetary Control Act 1980 brought about big
changes in banking – very little difference exists
now between member/non-member
 ALL Depository institutions in U.S. are now
under the jurisdiction of the Fed-which applies
regulations on each and offers services to each (
check-clearing service used to be a moneymaker-) Big banks have always exchanged
checks among themselves. Others send to
District for clearing. What has the Debit Card
done to this service?
12 DISTRICT BANK
STRUCTURE/DUTIES
 Each bank has 9 on Board of Directors
 6 members chosen by member banks,
 3 chosen by BOG *only 3 may be bankers- why?
 Oversees operations of member banks
 Set interest-rate bank may charge for short-term collateral
loans Approve member banks Pres and VP
 Clearing house for check from all regions
 Researches the economic health of the region-beige book.
AUTONOMY OF FEDERAL
RESERVE
Fed operates independently of Congress or Executive
Branch- autonomous
Congress does not fund the Fed. Earnings made on
financial assets, mostly government bonds- provides more
funding than needed- rest returned to Treasury.
Each District Bank receives a % of assets from member
banks and other services DB provides (check clearing/not
much anymore why? Revenue lost by Fed????)
Fed does not undergo GAO Audits (Government
Accountability Office)
Was set-up to be apolitical.
3 Monetary Tools for the FED
1.
Reserve Requirement
2.
Discount Rate
3.
FOMC
One Tool to Control Money Supply
Reserve Requirement
Lowering RR =
creating more money
to loan
b) Raising the RR=
decreasing money
creation.
RR’s do not change very
often.Changes in RR
can be disruptive of
banking operations.
RR change could force
banks to sell securities
quickly or call in loans
to meet the Fed
requirement.
Current: 3% 0- $79.5 Mil
10% $79.5+
a)
 The Fed requires banking
institutions, including S&Ls,
Credit Unions, Loan Assns,
to maintain reserves against
the demand deposits of their
customers. Required and
excess are important
concepts
 Required Reserves are: vault
cash and deposits held for
them at the Fed.
 This RR can alter the loans
that members can make by:
Amount to be held on reserve
 All banks as of 2014
Current: 3% 0- $79.5
Mil
10% $79.5+
Big Banks (8 largest
banks)
Current (2014) 5% - $68
billion.
Will affect Goldman Sachs
and Morgan Stanley
most who do not have
retail banking operations
to accept cash deposits.
How Fractional Banking Works
Fed RR is 20%(bank required to hold a
percentage of its deposits on RR
Deposit made = $100,000
-20,000 (bank holds in reserve
$ 80,000 (bank can loan this amount)
This $80,000 is considered new money
Whoever receives the $80,000 as a loan then deposits it
into an account and can write checks immediately, but
the bank views it as “never seen before.”
CONTINUED RR/FRACTIONAL BANKING
EXAMPLE
$80,000
-16,000 (20% reserve required)
$64,000 (potential new loan which can be
created and loaned out to another customer
$64,000 new deposit in mind of bank
- 12,800 (20 % must be kept in reserve)
$51,200 considered new money available for
loan
CONTINUED RR/FRACTIONAL EXAMPLE
This cycle keeps going on and on-
The multiplier factor for 20% RR is 5 to 1
Using the above example- banks could create 5
times the $100,000 at 20% reserve required or in
other words, it can create $500,00 “NEW MONEY”
At 25% required as opposed to say 10%- higher
requirement would lower the multiplier effect from
10 to 4 which in turn would not allow banks to have
as much money to loan- or would be taking money
out of circulation.
Summary/RR/Fractional Banking/Multiplier
 The higher the required reserve- the lower
the multiplier.
 The potential deposit expansion multiplier is
merely the reciprocal of the required reserve
ratio (r ) In case of 20% example or l/5 of
total deposits to be held- deposit expansion
multiplier is 5
 If 10% was to be held- deposit expansion
multiplier is 10.
DOES MULTIPLIER ALWAYS
WORK? no
Creating New Money with the deposit expansion
multiplier effect will not work if:
All excess reserves are tied up. (purchase securities,
loans, etc.)
If person receiving the loan decides to hold currency
rather than deposit it into the bank
If banks decide not to extend loans even though they
have excess reserves available (referred in the early
90’s as “credit crunch.” And… happened after TARP
and QE – to some extent still in place today!
WAMU Syndrome
 Confidence!
 Do you have confidence in your bank?
 If no… take your money and run
 Self-fulfilling prophecy.
SECOND TOOL TO CONTROL MONEY
SUPPLY- DISCOUNT RATE
 There are two types of interest: Simple and
discount.


Simple- paid each time a payment is made on the loan.
Discount- entire amount of interest owed is deducted from
loan before it is issued
Discount Rate Continued
The Discount Rate is the interest rate charged to member banks
that borrow from the Fed District Banks.
Why would a member bank need to borrow from the
“mother fed?”
 Firms would go to their bank and request a loan… If bank had
used its excess reserves, the commercial bank would then go to
the District Bank to borrow the money.
 The Commercial Bank would write an IOU to the District bank
with asset collateral tied usually to government securities held
at the District Bank.
 The District bank would deduct whatever the Discount Rate of
interest was from the requested amount and credit the
commercial bank’s account.
Continued Discount Rate
 These loans are generally overnight or short-term.
 When money is transferred back to District to pay off
IOU – the entire amount of the loan is due.
 Say you borrowed $1,000 and the interest rate was 8
percent, the interest is deducted = $80 and the
commercial bank account is credited $920…
 All the bank gets is $920, but pays back $1,000
Setting up Prime Rate
 District Bank is not a charity bank… charges
interest on money loaned to member banks.

If Member Bank borrows $100,000 at 10%

The interest is discounted up-front- Member has
$90,000 to take back to loan.

Member bank is not going to loan at 10%

Adds 2 to 3 points to constitute prime rate. In this
example is 13%
Discount Rate continued


If ordinary citizen wants to borrow, points added to prime
depending on type of loan, collateral, history, etc.
Say 13% is Prime…. Points added 3 or 4 for ordinary person
(remember, they build in inflation premium too.)

Prime rate is always higher than discount- each bank sets own
prime, but large banks tend to all have the same.

Prime is rate given to best corporate customers.
DISCOUNT RATE CONTINUED
 If Fed wants to cut down on bank loans, they
can raise the discount rate.
 Recently the Fed lowered the discount rate to
encourage loans
 **Banks will borrow from Federal Funds Rate
before going to the Fed to borrow. Too many
trips to the Fed to borrow signals poor fiscal
management of the bank
 What is the Federal Funds Rate? The rate banks
can charge (as set by the BOG) for short-term
loans between each other – often overnight.
 Federal Funds rate will be lower than discount
rate. Why?
Discount Window Primary and Secondary
Lending Rate
The FF Target is the target
for interest set by the
FOMC.
This triggers either the
buying or selling of
government bonds on the
open market.
Done by dealers through
the securities desk at NY
FED.
Primary Credit
.75%
Secondary Credit
1.25%
Seasonal Credit
.20%
Fed Funds Target
.25%
THIRD TOOL TO CONTROL OPEN
MARKET COMMITTEE (FOMC)
 This is the most common tool used by Fed to alter






the money supply.
Buying and Selling of U.S. Securities on the open
market
FOMC meets about every six weeks.
FOMC = all 7 BOG, 12 District Presidents
N.Y. President permanent member, other 11
Presidents rotate on the voting 12 on yearly basis.
FOMC constitutes 12 persons who vote.
Can directly influence the money supply in a nondisruptive way.
FOMC Continued
 FED can write a check without funds in an account so
to speak.
 FED holds large portfolio of U.S. government
securities
 FED engages in open market trading with
approximately 3 dozen major securities dealers.
A SELL OPERATION
 When Fed wishes to restrain money supply growth, the
Fed sells U.S. government securities on the open
market.
FOMC Continued
Securities dealers then pay the Fed from deposits
held at their banks, and the Fed simply deducts an
equivalent amount from the banks’ reserve
account.
 As result- banks have less credit in reserve-(taken
from excess reserves) and cannot make as many
loans
 Banks might even have to sell some of their
investments… reduced supply of credit throughout
the banking system.
 FED controls this operation by enticing banks
to buy government securities by offering “good
deals.”
 Example: Treasury Bond issued to FED.
$10,000. FED offers this Bond interest to
pay a fixed rate of 10% yearly until bond
expires.- Fed goes to bank and says (sell this
$10,000 bond for $8,000 – still pay the 10%(this is selling below par)
 This pulls lump sum out of circulation
(actual rate bank will make over bond life is
12l/2 % . Money supply has shrunk.
If the banks elect to buy- less money to
loan.
Banks can only buy government
securities..Cannot buy corporate bonds.
FOMC CONTINUED
BUY OPERATION:
 When FED wants to increase the money supply, it
reverses the procedure and purchases U.S. government
securities on the open market. It then credits the reserve
accounts of the banks in which securities dealers keep their
deposits. End result is that banks have more funds to lend.
 Example: Fed offers to buy the $10,000 bond sold
on open market for $12,000. Bank sells- this puts
money in circulation or creates potential for banks to
loan more to member banks.
FOMC CONTINUED
 Open Market is not in the business to make money



they actually lose money on most transactions
Main function is to control loans the banks can
make.
Securities desk in N.Y. puts the bonds for buy or
sell out to Security dealers for best bid.
Every security purchased lowers the money supply.
FED can use this tool as major way to offset cyclical
economic swings. Can also supply money for
seasonal adjustment demands made by business
and consumers. Or, as we saw, provide money
when disaster strikes.
 FOMC assesses growth operations
directed to 4 objectives:
 full employment,
 economic growth,
 stable prices and
 balance of payments.
 No bank will ever loan
out ALL of its excess
reserves This would leave them
with no flexibility in
buying Govt
Securities.
 Banks are in business
to make a profit!
 Voting FOMC members
 Chairman Janet Yellen
 7 Federal Board of




Governors
5 regional Reserve Bank
presidents
Guess who is boss?
Her term as Chairman is
till 2018. Term on BOG
over January, 2024.
Prior to the FED, Dr.
Yellen was an economic
professor at Berkley.
History of Why American
Banks were created
The war left us in debt. Some states were
bankrupt. We needed one unified currency ...
Hamilton suggested a central bank. The First
Bank's charter was drafted in 1791 by the Congress
and signed by George Washington. In 1811,
Congress voted to abandon
EARLY PROBLEMS OF U.S. BANKING
SYSTEM.
Before the Fed was established 1913- U.S. could not adjust
supplies of money to business activity
Banks were often short of cash- if people deposited their
money- wanted it on the spot, had legal right to withdraw it.
Banks often kept some $ in their reserve accts, and
deposited money in other banks.
Sometimes demand for currency was >than the amount of
money on hand.
Banks would draw on deposits from other banks and sell
other assets such as government securities.
https://www.youtube.com/watch?v=E
OzMdEwYmDU
U.S. Banking- 1970 to Present
Technology has changed banking
No cancelled checks, electronic transfers,
Online banking, etc.
See a lot of banks merging
Services of banking changed today from
1970
Many new regulations, Monetary
Deregulation Act (80’s) other regs later
after massive bank and S&L failures in
late 80’s early 90’s.
Government in BankingHelp or Hindrance?
S&L Debacle! (late 80’s)
Worst financial disaster since Great Depression *until now
Inflation was eating away at profits for S&Ls
Began to make very risky mortgage loans.
Could not recoup from all loans that were made at such low
rates- Went bankrupt.
Then Congress deregulated the S&L to allow them to act like
banks. *Beginning of our current debacle.
Monetary Deregulation Act of 1980… This created a tumble in
the market then the Fed had to bail out at taxpayers
expense.
FDIC actually took over Continental Illinois Bank (too big to
fail.)
The collapse of Continental Illinois National Bank and Trust was a
watershed event in
modern banking history that holds lessons for both bank risk
managers and regulators. It
showed how quickly the revelation of credit problems at a wellregarded bank could turn
into a liquidity problem that jeopardized not only the survival of
the bank itself, but also,
in the view of the US regulators, the financial system.
Today…. It’s TARP
 Troubled Assets Relief Program (TARP): In
October 2008, Congress enacted the Emergency
Economic Stabilization Act (EESA) to respond to
instability in U.S. financial institutions, caused
particularly by these institutions' being saddled
by delinquent mortgages. That legislation created
the Troubled Asset Relief Program (TARP).
So… what’s the bottom line?
 Beginning government – attempt at
national banking… that failed
 States wanted to control banking and that
failed.
 Chaos evident with no confidence and
market crashes/ depression- banks
failed… attempt to re-build national
stability
 For a period of years, banking stability
seemed assured.
 In 2010 banking took
a turn back to instability.
Banks Today!
 Community Reinvestment Act (Carter Administration)-
required banks to provide loans to low-income families.
 Continued with no-income families.
 Banks bundled the risky loans- sold paper- good
investment for other banks, financials, global players
entered here also.
 Continued for about 10 years, with banks continuing the
risky loans.
 Hedge fund investors played their cards, and entered the
scene.
 Off to the races!
Bailout Begins!@ U.S. Government.gov
Federal Reserve/Treasury Department have
orchestrated the biggest bailout of banks, financials,
Fannie and Freddie, AIG, etc. etc. The automobile
industry is also in on the act.
 Fed has pumped billions into system (QE1, QE2,
QE3)
 Treasury has trillions extra and
 200 billion for Fannie and Freddie
What is a billion?




A billion seconds ago it was 1959
A billion hours ago our ancestors were living in the Stone Age.
Approximately $250 billion was requested to re-build New Orleans.
Here is how many million it takes to equal $1 Billion:
$1,000,000.00 +1,000,000.00 +1,000,000.00 +1,000,000.00 +1,000,000.00 +1,000,000.00
+1,000,000.00 +1,000,000.00 +1,000,000.00 +1,000,000.00 +1,000,000.00 +1,000,000.00
+1,000,000.00 +1,000,000.00 +1,000,000.00 +1,000,000.00 +1,000,000.00 +1,000,000.00
+1,000,000.00 +1,000,000.00 +1,000,000.00 +1,000,000.00 +1,000,000.00 +1,000,000.00
+1,000,000.00 +1,000,000.00 +1,000,000.00 +1,000,000.00 +1,000,000.00 +1,000,000.00
+1,000,000.00 +1,000,000.00 +1,000,000.00 +1,000,000.00 +1,000,000.00 +1,000,000.00
+1,000,000.00 +1,000,000.00 +1,000,000.00 +1,000,000.00 +1,000,000.00 +1,000,000.00
+1,000,000.00 +1,000,000.00 +1,000,000.00 +1,000,000.00 +1,000,000.00 +1,000,000.00
+1,000,000.00 +1,000,000.00 +1,000,000.00 +1,000,000.00 +1,000,000.00 +1,000,000.00
+1,000,000.00 +1,000,000.00 +1,000,000.00 +1,000,000.00 +1,000,000.00 +1,000,000.00
+1,000,000.00 +1,000,000.00 +1,000,000.00 +1,000,000.00 +1,000,000.00 +1,000,000.00
+1,000,000.00 +1,000,000.00 +1,000,000.00 +1,000,000.00 +1,000,000.00 +1,000,000.00
+1,000,000.00 +1,000,000.00 +1,000,000.00 +1,000,000.00 +1,000,000.00 +1,000,000.00
+1,000,000.00 +1,000,000.00 +1,000,000.00 +1,000,000.00 +1,000,000.00 +1,000,000.00
+1,000,000.00 +1,000,000.00 +1,000,000.00 +1,000,000.00 +1,000,000.00 +1,000,000.00
+1,000,000.00 +1,000,000.00 +1,000,000.00 +1,000,000.00 +1,000,000.00 +1,000,000.00
+1,000,000.00 +1,000,000.00 +1,000,000.00 +1,000,000.00
EARLY BANKING
 Under what authority can
the U.S. Treasury print
dollars?
(Article I, Section 8, clause
5)
 In early days:
most banks were state
banks – issued their own
currency backed by their
own supply of either gold
or silver
 Bank of the U.S. – only
national bank- acted
much like the U.S.
Treasury by collecting and
paying debts owed to the
federal government
 No regulation of state
banks-no limit on amount
of currency they could
print.
 Early years- many banks
went bankrupt.
Additional info on Banking….legalities
Has Congress the power to incorporate a bank? (Yes,
“necessary and proper clause”
“to make all laws which shall be necessary and proper for
carrying into execution” the expressed powers in the
Constitution.”
May a state tax a U.S. Bank?
(No, the power to tax involves the power to destroy.
Such a tax could be used to destroy an institution vitally
necessary to carry out the operations of the federal
government, and therefore is unconstitutional and void.
McCulloch vs. Maryland (1819)
Early Banking Revisited
 In beginning Civil War- 1861- Congress authorized
printing of demand notes- later called Greenbacks (ink
was green)
 People skeptical- so National Banking System was
created and national bank notes were printed.
 1863- Gold certificates were issued- This was paper
currency backed by gold on deposit with U.S. Treasury
 1866- federal government issued Silver Certificatesmodeled after gold certificates and backed by silver coins.
(remember the parable of Wizard of OZ?)
Early Banking
 GOLD STANDARD- 1900 Congress passed
the Gold Standard Act- tied to the basic unit
of currency and equal to it. Currency could be
traded in for gold- people felt secure.
Advantage: confidence of people- prevented
government from printing too much currency.
 Disadvantage- economic growth is tied to the
money supply – no flexibility for productive
growth.
 Most countries between 1871 and 1914 were on
Gold Standard. U.S was last to get on.

Early Banking Continued
 1933- U.S. government went off the gold standard
 Britain went of two years earlier.
 1934 Gold Reserve Act passed- required citizens to turn
in their gold and gold certificates- people were given
Federal Reserve Notes in exchange- those who refused to
turn in gold had their gold confiscated
 1971- President Nixon declared no gold backing whatever
for dollar- placed the exchange equivalent with other
currencies (dollar v pound v yen v mark) (now in 2008…
dollar v pound v Euro) Gold window was closed!
 And as we know, the dollar will fluctuate with currency
market. .Referred to as
Exchange rate.
Supply and Demand for Credit
•Banks and other lending institutions lend money- expect
to be paid for its use.
•Amount they lend (subject to some legal restrictions) is
determined by how much they have to lend and how much the
borrower is willing to pay.
•This charge or price for use of money = interest
The Supply of Money
The supply curve of
money is a vertical
line at the quantity
of money, which is
largely, but not
exclusively,
determined by the
Fed.
Equilibrium in the Money Market

At an interest rate
of i1, the money
market is in
equilibrium: There
is neither an excess
supply of money nor
an excess demand
for money
 Interest rates fluctuate with changes in demand for
money in relationship to changes in supply of money
available.
 Money becomes valuable just like other value created
for other commodities (demand relative to supply)
 So when the FED began lowering the FF Rate, and
money was almost “free,” did this help or hinder the
financial crisis ????
PART III
FED AS THE NATION’S CENTRAL
BANK
MONETARY POLICY AS REQUIRED BY Congress
 Provide a flow of credit and money that will foster
economic stability and growth
 Establish a high level of employment
 Provide stability in purchasing power of the dollar.
 Reminder- Fed is autonomous
Three principal tools to implement monetary policy:
1. Reserve requirements
2. Discount rate
3. Open market operations
What Indicators does the Fed check?
Real Gross Domestic
Product (GDP)
 Consumer Price Index
(CPI)
 Nonfarm Payroll
Employment
 Housing Starts
 Industrial
Production/Capacity
Utilization
 Retail Sales

Business Sales and
Inventories
 Advance Report on
Durable Goods Shipments
 Light-Weight Vehicle Sales
 Yield on 10-year Treasury
Bond
 S&P 500 Stock Index
 M2 Money Supply

Money and Production
 Money is the means of helping to facilitate
our economic purposes of production,
distribution, and consumption of goods and
services
 Relationship between money supply, price
levels and business is important aspect of
macro theory.
 Equation of Exchange: MV=PT or MV=PQ
Money x Velocity = Prices x Business
Transactions (real levels of output)
MV= total spending for the year (velocity is #
times $ turns over in a year )
PQ= total business for that year.
If any of these get out of balance- economy out
of sync.
Equation of Exchange
 MxV≡PxQ
where:
M represents Money Supply
V represents Velocity*
≡ means must be equal to
P represents Price
Q represents Real GDP
*The average number of times a dollar is spent to
buy final goods and services in a year
 We want the economy to grow, but
while growing maintain stable price levels.
Necessary to balance an increase in actual
production (T) with an increase in spending or
(MV)
BIG PICTURE FOR FED
 To forestall depressions in
period of prosperity
 To stimulate the economy in
period of declining economic
activity.
 I.E. To smooth out the
swings of the business
cycle… uses counter-cyclical
moves
Remember!
 Inflation is Bad!!!
 Inflation is Bad!!!
 Inflation is Bad!!!
MONETIZING THE DEBT
S1
Supply of
Money
Before
expansion
1.
When the government borrows to
Cover a deficit in the federal budget,
Interest rates tend to rise because of the
Increased demand for credit (raising the
Possibility of “crowding out.”
S2
Supply of Money
After Expansion
Interest
rate
Demand After
Government
Borrowing
12
10
Demand
Before
Government
borrowing
D1
D
Quantity of money
What are the long-run effects of
monetizing the debt?
So, are you better off?
Or is the federal government the Grinch?